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SEC Withholds Records on Oversight of Self-Regulatory Group

Suzanne Barlyn's latest column in Dow Jones Compliance Watch raises new concerns about the Securities and Exchange Commission's (SEC) Freedom of Information Act (FOIA) practices and the lack of transparency at the Financial Industry Regulatory Authority (FINRA) and other self-regulatory groups.

Finra
 

Barlyn reports that the SEC is refusing to hand over records to the Public Investors Arbitration Bar Association (PIABA) regarding the SEC's oversight of the forced arbitration process at FINRA, the self-regulatory organization for the securities industry.

Although it is considered to be a private organization, and therefore not subject to FOIA, FINRA has been given significant authority to assist the SEC in its regulation of the securities industry. Among its many regulatory activities, FINRA runs the largest dispute resolution forum in the securities industry, including a process through which investors can bring claims before an arbitration panel that is supposed to be comprised of "impartial persons who are knowledgeable in securities industry disputes." Arbitration is often mandatory in securities disputes, and arbitration awards are typically binding, "subject to review by a court only on a very limited basis," according to FINRA's website.

Many consumer groups have raised concerns that forced arbitration denies investors and consumers their constitutional rights to sue in court when they've been harmed by a company.

Last year, PIABA filed a FOIA request seeking records on the SEC's oversight of FINRA's process for selecting arbitrators. The SEC denied PIABA's request under FOIA Exemption 8, which "protects from disclosure records that relate to examination, operating, and condition reports, prepared by or on behalf of the Commission, in connection with its supervision and regulation of financial institutions."

PIABA appealed the SEC's decision, arguing that the release of these documents would not endanger FINRA's stability as a "financial institution," nor would it undermine the SEC's ability to oversee FINRA. But the SEC's Associate General Counsel upheld the original decision, finding that the records were "obtained or created during the course of an inspection conducted by Commission staff," and that the information "facilitates the staff's oversight and supervision of this self-regulatory organization's activities."

As Barlyn points out, some people might be surprised to learn that the SEC's review of a self-regulatory group would be withheld under the same exemption that normally protects the records of banks and other financial firms examined by federal regulators:

The SEC cites an exemption to FOIA that allows it and other regulatory agencies to keep secret their dealings with "financial institutions," a term that would seem to naturally apply to the banks, brokerages and the like. Some degree of confidentiality in those relationships might seem reasonable.

But according to the SEC, Finra also falls into that category despite its role as a watchdog, not a broker dealer or bank....

Piaba's FOIA letter was very limited in scope, asking for documents related only to the SEC's oversight of how Finra selected arbitrators. The lawyers weren't asking for the types of sensitive financial details related to brokerage firms that you'd think the exemption was aimed at covering, such as investors' personal financial statements or brokerage firms' trading records.

When she came to the SEC in 2009, Chairman Mary Schapiro announced her intent to "deepen the SEC's commitment to transparency, accountability, and disclosure while always keeping the needs and concerns of investors front and center." The SEC's handling of PIABA's FOIA request, however, raises concerns about the SEC's commitment to providing more information on FINRA, Chairman Schapiro's former employer.

This also isn't the first time that the SEC's use of Exemption 8 has caused POGO to question Chairman Schapiro's commitment to SEC transparency. Last year, POGO's Angela Canterbury testified before Congress about an SEC-supported provision in the Dodd-Frank financial reform law that could have given the agency sweeping new powers to hide its records from public scrutiny. At the same hearing, Chairman Schapiro argued that one of the reasons the SEC needed this blanket secrecy provision was to remove any legal uncertainty surrounding the application of Exemption 8 to firms regulated by the SEC, including new categories of firms that had fallen under the SEC's jurisdiction as a result of the Dodd-Frank reforms. As Dan Jamieson of Investment News wrote at the time, this provision had the potential to expand FINRA's "long-established exemption from public disclosure."

The following month, President Obama signed into law a bill to remove the SEC secrecy provision. The bill also clarified that "any entity for which the Commission is responsible for regulating, supervising, or examining under this title is a financial institution" for the purposes of Exemption 8.

The SEC's response to PIABA's FOIA request shows that the agency is embracing this broad definition of "financial institution" with regards to FINRA. It also underscores the need for a review of how the SEC and other agencies are using Exemption 8 to withhold information from the public, a point we made in our testimony last year:

In fact, there is sufficient concern that Exemption 8 is too broad, and should be re-examined and more narrowly tailored. The Administrative Conference of the United States made the recommendation that "Agencies should not withhold information on the basis that it is 'related to' operating, condition or examination reports unless they determine that nondisclosure is properly justified."...

Congress should examine the use of Exemption 8 and then should supply clear standards for employing it....[R]egular periodic studies on the SEC's use of FOIA exemption authorities with particular emphasis on how the expanded Exemption 8 has helped SEC with its examinations and investigations are needed.

As Congress considers granting additional authority to self-regulatory groups to assist the SEC in its regulation of financial markets, it is more important than ever for the SEC to be transparent about its oversight of these groups. In addition, the SEC should continue to allow voluntary arbitration, but should consider limiting or banning the use of mandatory binding arbitration in securities disputes.

Image by Flickr user lobstar, used under Creative Commons License.

By: Michael Smallberg
Investigator, POGO

Michael Smallberg, Investigator Michael Smallberg is an investigator for the Project On Government Oversight. Michael's investigations center on oversight of the financial sector.

Topics: Financial Sector

Related Content: FINRA

Authors: Michael Smallberg

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